Markets & Finance

Central Bank sets borrowers on path to high cost loans


From left: Terry Ryan (centre), a member of the Central Bank of Kenya’s Monetary Policy Committee, with Kenya Bankers Association officials Frank Ireri (left) and Habil Olaka at a recent event. PHOTO | FILE

The Central Bank of Kenya (CBK) on Tuesday raised the benchmark interest rate to 10 per cent from 8.5 per cent, setting the stage for a rise in the cost of loans in the coming months.

The CBK’s Monetary Policy Committee (MPC) said it took the action after noting that increased demand for goods and services had pushed up prices — and combined with a weakening shilling had the potential to destabilise markets.

“The MPC therefore decided to augment its tightening stance by raising the CBR by 150 basis points from 8.50 per cent to 10.00 per cent. We will continue to monitor developments in the external and domestic economies and their implications on the risks to the overall price stability,” Haron Sirima, the CBK’s deputy governor and the MPC vice-chairman, said in a statement.

The shilling has in past couple of weeks weakened to its lowest level against the US dollar in more than three years, pushing the overall inflation rate close to the 7.5 per cent medium term ceiling set by the Treasury.

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The rise in the benchmark rate, also known as the Central Bank Rate (CBR), has the effect of raising the cost of funds for commercial banks, who are expected to pass it on to the borrowers in the form of higher lending rates.

Lending rates have been stable at an average of 15.4 per cent in the past 12 months, having dropped from 16.91 per cent last July.

It is the first time since April 2013 that the MPC has changed the CBR. The policy rate stood at 9.5 per cent in March 2013, having been initially set at that level in January of the same year. It then dropped to 8.5 per cent in April 2013, where it remained for 26 months.

Analysts expect the shilling to register a modest gain saying there was still a big negative gap between exports and imports (also called current account deficit).

“In the near term, we expect the shilling to appreciate modestly on the back of this rate hike, although a still-wide current account deficit suggests that a full reversal of the shilling’s depreciation is unlikely,” said Razia Khan, the head of research on Africa at Standard Chartered.

Ms Khan said that by raising the CBR by 1.5 percentage points, “the MPC has underscored its anti-inflation credentials and the shilling has benefited as a result.”

Dr Sirima said the CBK had begun to tighten liquidity in the money markets through frequent mop-ups and by increasing the rate on the treasury auction deposits (an instrument of reducing cash in circulation) by 2.5 percentage points above the CBR.

The tightening has been evident in money markets where the interbank rate — the rate at which commercial banks borrow from each other overnight to cover temporary liquidity shortfalls — rose by more than five percentage points to about 13 per cent in a couple of months.

Joseph Kieyah, an economist with the Kenya Institute of Policy Research and Analysis (KIPPRA), said the 1.5 percentage point raise in the policy rate reflects the CBK’s attempt to balance stabilising the currency against keeping the economy growing by not raising lending rates too high.

“The central bank has the task of ensuring that the shilling is not too weak and that lending rates are affordable. It has to balance these interests. It has all the information it needs to make that decision,” said Prof Kieyah.

The last time that the MPC increased the CBR by 1.5 percentage points at a go was in December 2011 when it set it at a historic high of 18 per cent from the 16.5 per cent set in November of the same year.

The action came in the wake of the shilling’s weakening to a historic low of Sh107 to the dollar in mid-October of the same year.

The MPC’s latest action came after weeks of criticism that it had failed to offer an appropriate response to exchange rate turbulence that saw the shilling depreciate from Sh87 to the dollar mid last year to Sh92 in March without any action.

The MPC was as a result forced to bring forward its regular meetings by one month as the shilling moved close to 100 units to the dollar and inflation moved closer to the upper limit 7.5 per cent.

Tuesday’s MPC meeting came one month after the one it held in early May. The last time that the MPC met with such frequency — that is, every month — was in early 2012 as it dealt with a crisis of both a weak currency and a high inflation.

Next month, the MPC is also scheduled to review the Kenya Bankers Reference Rate (KBRR), which last changed in January to 8.54 per cent from 9.13 per cent set last July.

The KBRR is reviewed every six months. Should the KBRR rise, there is a high chance of further escalation in lending rates.

Dr Sirima noted that not only was the overall inflation rate in the upper band of the accepted range but the non-fuel non-food inflation (also called core inflation), which is influenced by demand in the economy, had also risen to 4.15 per cent in May from 3.16 per cent in March.

This indicated, he added, that the weakening of the shilling was beginning to cause an increase in prices in the domestic economy.

“This increase mainly reflected inflationary pressure on tradable goods on account of the pass-through from the weakening of the Kenya Shilling against the US dollar,” said Dr Sirima.

He, however, maintained that the shilling was well cushioned going forward given the current level of foreign exchange reserves at $6.7 billion or 4.26 months of import cover and the precautionary facility — where Kenya can access forex at short notice — offered by the International Monetary Fund early this year.